Changing Expectations: The New Test of Expedience for CIRP Applications

The authors are Harshit Singh and Akshata Modi, third-year students at Gujarat National Law University.

I. BACKGROUND

The Insolvency and Bankruptcy Code, 2016 [“Code”] provides for the initiation of Corporate Insolvency Resolution Process [“CIRP”] by both financial creditors and operational creditors against corporate debtors in cases of default in repayment of debt. A financial creditor may file an application for initiation of CIRP under Section 7 of the Code, whilst an operational creditor would file the same under Section 9. Through the landmark judgements given in M/s Innoventive Industries Ltd. v. ICICI Bank & Anr. [“Innoventive Industries”]and Swiss Ribbons Pvt. Ltd. v. Union of India [“Swiss Ribbons”], the Supreme Court of India defined the scope and applicability of Section 7. The court laid down a two-pronged test for admitting an application by a financial creditor for the initiation of CIRP, as per which, the financial creditor should establish that:

i) an obligation to pay, or a debt exists, and

ii) the corporate debtor defaulted in making repayment of such debt.

The court observed that upon satisfaction of the above test, the adjudicating authority must admit the financial creditor’s application and trigger the CIRP. The Supreme Court further observed in Swiss Ribbons (supra) that “no other extraneous matter should come in the way of expeditiously deciding a petition under Section 7 and Section 9 of the Code”.

A recent judgement of the Supreme Court, given in the case of Vidarbha Industries Power Limited v. Axis Bank Limited [“Vidarbha Industries”], completely departs from the established precedent regarding the interpretation of Section 7. Through this judgement, the court conferred discretion upon the adjudicating authority, i.e., the National Company Law Tribunal [“NCLT”] to admit or reject the application of a financial creditor. Such discretion would prevail irrespective of the fulfilment of the aforementioned test. Through this article, the authors analyse this departure of the Supreme Court from the established precedent and the potential implications that it could have in the corporate arena.

II. BRIEF FACTS OF THE CASE

Vidarbha Industries Power Ltd. [“Appellant”] is an electricity generating company. The appellant entered into a power purchase agreement with Reliance Industries Limited. The tariff on the power supply was regulated by the Maharashtra Electricity Regulatory Commission [“MERC”] and the Appellate Tribunal for Electricity [“APTEL”]. Pursuant to a favourable order passed by the APTEL regarding the determination of tariff by the MERC, the appellant was expecting an amount of INR 1,730 crores. This order was challenged by the MERC in the Supreme Court. Due to the pendency of this appeal, the Appellant could not implement the order and found itself in a shortage of funds to make repayments of its debts.

Axis Bank Limited [“Respondent”] was a financial creditor of the Appellant. The Respondent filed an application against the Appellant before the NCLT under Section 7(2) of the Code for the initiation of CIRP.

The Appellant then filed a miscellaneous application in the NCLT, seeking a stay on the proceedings under Section 7 until the appeal filed by the MERC remained pending in the Supreme Court. The NCLT dismissed the application and refused to stay the CIRP, deeming it mandatory to admit the application filed under Section 7 since there existed a debt and a default. The NCLT further observed that the appeal filed by the MERC being pending before the Supreme Court is an extraneous and irrelevant consideration while admitting an application for the initiation of CIRP.

The Appellant challenged this order in the National Company Law Appellate Tribunal [“NCLAT”]. The NCLAT dismissed the appeal and upheld the order given by the NCLT, citing the mandatory requirement under Section 7(5). Subsequently, the Appellant challenged the order given by the NCLAT before the Supreme Court.

III. JUDGEMENT OF THE SUPREME COURT

Application of mind by Adjudicating authority

Placing reliance on Swiss Ribbons (supra), the Supreme Court reiterated in Vidarbha Industries (supra) that “no other extraneous matter should come in the way of deciding a petition under Section 7 or Section 9 of the IBC”. However, the court widened the ambit of “extraneous matter” and held that “the viability and overall financial health of the corporate debtor is not an extraneous matter”. It was observed that the existence of debt and default merely gives the financial creditor the right to apply for CIRP. The court established that the adjudicating authority is required to apply its mind to relevant factors while deciding upon the initiation of CIRP.

Section 7(5)(a): mandatory or discretionary provision?

Highlighting that Section 7(5)(a) of the Code uses the expression “may”, the court applied the rule of literal interpretation and construed that this provision confers discretion upon the adjudicating authority while admitting an application under Section 7. Departing from the established precedent, it was observed by the court that Section 7(5)(a) is not a mandatory provision, but a discretionary one.

Difference between initiation of CIRP by an operational creditor and a financial creditor

The Supreme Court underlined that Section 7(5)(a) uses the expression “may”, however, Section 9(5)(a), which pertains to the initiation of CIRP by an operational creditor, uses the expression “shall”. The court observed that the legislative intent behind the provisions was for Section 9(5)(a) to be mandatory and Section 7(5)(a) to be discretionary. It was held by the court that an application filed by an operational creditor is mandatorily required to be admitted by the adjudicating authority if it is in compliance with all the requirements laid by Section 9 of the Code. However, in an application filed by a financial creditor under Section 7, the adjudicating authority should examine the “expedience of initiation of CIRP” by taking into consideration all relevant factors, including the overall health and viability of the corporate debtor. The adjudicating authority may, at its discretion, keep an admission in abeyance or reject an application of a financial creditor, even if the conditions of debt and default are established.

IV. ANALYSIS OF THE JUDGEMENT

Delays in the admission stage and protracted litigations

Time is of the essence when it comes to initiation of insolvency proceedings since any delay in the admission stage may lead to further value erosion of the corporate debtor, who is already in the red. The point of trigger of a corporate insolvency may be hampered due to delays at the stage of admission. Hence, having a clear and objective criteria for admission of insolvency applications is essential for faster resolution of distressed companies. This would further preserve the value of the corporate debtor and all stakeholders would collectively benefit.

The two-pronged test of debt and default as established by the Supreme Court, provided for a clear and objective criteria for triggering CIRP. However, the present judgement has radically altered these expectations of the industry by introducing the expedience test. The NCLT can now exercise discretion to look beyond debt and default, and examine whether it is expedient to initiate CIRP against the corporate debtor by taking into account other relevant factors. The parameters for applying this discretion are very broad and will lead to subjectivity in the adjudication process, resulting in unnecessary delays and protracted litigations. Furthermore, the judgement does not suitably elaborate upon the factors which should be characterised as extraneous by the adjudicating authorities. This may lead to conflicting views and inconsistency amongst different benches of the NCLT.

Potential anomalies caused by the filing of applications by both financial and operational creditors

The present judgement has laid down a distinction between applications filed by a financial creditor and an operational creditor. An adjudicating authority will have to necessarily admit an application filed by an operational creditor for initiation of CIRP. However, for an application filed by a financial creditor, the authority will now have discretionary power to examine the expedience of initiating the CIRP. Thus, in situations wherein both financial and operational creditors file applications for the initiation of CIRP before the adjudicating authority, the authority might use its discretion and keep an application filed under Section 7 in abeyance, while at the same time, admit the application filed by the operational creditor under Section 9. This anomaly will lead to incongruous and inequitable outcomes. It may also lead to situations wherein an application filed by an operational creditor is given preference over the application filed by the financial creditor, even if the financial creditor’s debt is significantly larger.

Departure from the legislative intent of the Code

While drawing a distinction between the words “may” and “shall”, as used in Section 7(5)(a) and Section 9(5)(a) respectively, the Supreme Court has placed undue reliance on the literal rule of interpretation. The court failed to take into account the underlying economic rationale and legislative intent of the Code. Moreover, the report of the Bankruptcy Law Reforms Committee [“BLRC Report”], on the recommendation of which the Code was formed, did not envisage for a subjective assessment to be carried out by the adjudicating authority for initiation of CIRP. Further, in Innoventive Industries (supra), the Supreme Court recognised the BLRC Report as one of the most important tools for the interpretation of the Code. In the present matter, the court departed from this established principle laid down by the report and the legislative intent of the Code.

V. CONCLUSION

This decision given by the Supreme Court has the potential to open floodgates to numerous litigations, and corporate debtors are likely to misuse this precedent for resisting the initiation of CIRP. This would result in unnecessary delays and would defeat the purpose of the Code. Even though the court warned adjudicating authorities against using their discretionary power arbitrarily or capriciously, this decision may have opened up a pandora’s box. The element of subjectivity created by this judgement can be rectified by chalking out specific guidelines for an adjudicating authority to follow while exercising discretion. A need has now arisen for the Supreme Court to list out the factors that should be considered in the test of expedience for preventing subjectivity and inconsistency from penetrating into the system. In order to avoid the NCLT from becoming a safe haven for corporate debtors to seek shelter, the adjudicating authorities should use this discretion judiciously and in the rarest cases.